Wednesday, November 24, 2010

How hedge funds have profitted from QE

With the Fed and the Euro Central Bank applying QE, excess liquidity has to flow somewhere, and that somewhere is emerging countries with strong economies, sound currencies and trade surpluses.  This capital flow is causing price inflation, forcing countries like Brazil and China to impose price controls, which always ultimately fail.   But they have to do something to choke off the hot money.

Meanwhile, the savvy hedge fund managers (even the ones looking over their shoulders at the FBI) are buying emerging market equities and commodities, and plowing their profits into buying credit default swaps on European debt, profiting on sovereign debt crises in Greece, Ireland, Portugal, and Spain.  As the prospects for sovereign debt default increases, the CDS insuring said default appreciates in value.  In other words, these bond speculators are betting on these countries defaulting on their debt obligations.

These so-called bond vigilantes have no conscience:  when they smell blood, they drive up yields on these sovereign bonds, making it harder for these countries to service their debts, and practically ensuring a default.  Of course, the respective government officials will blame the speculators for driving their countries into the ground, but they conveniently ignore the fact that it was the government that recklessly spent money they didn't have, and hence, attracted the bond vultures in the first place.

The problem intensifies when the debt contagion spreads to Italy, France, and eventually Germany, the last stronghold in the Euro community.  The UK, Japan, and the US will not be far behind.

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